Chapter 9: Long-Term Liabilities – Bonds Payable, Amortization, and Financial Statement Impact

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Long-Term Liabilities

Bonds Payable: An Introduction

Bonds are a common form of long-term debt issued by companies to raise capital. A bond certificate contains essential information about the debt agreement.

Debts of an issuing company: Bonds represent amounts owed by the issuer to bondholders.
Bond certificate states:
- Issuing company’s name
- Principal (face value, maturity value, par value)
- Maturity date
- Annual interest rate
- Interest payment dates
Example: A company issues $100,000 in bonds with a 9% annual interest rate, maturing in 5 years.

Types of Bonds

Bonds can be classified based on their maturity structure and security features.

Term Bonds: All bonds in the issue mature at the same time.
Serial Bonds: Bonds mature in installments over time.
Secured Bonds: Bondholders have rights to specific assets if the issuer defaults.
Unsecured Bonds (Debentures): Backed only by the issuer’s general creditworthiness.

Bond Prices

The price of a bond is determined by market conditions and is quoted as a percentage of its maturity value.

Bond Premium: Issued above face value (credit balance).
Bond Discount: Issued below face value (debit balance).
Time Value of Money: The present value of future cash flows affects bond pricing.

Interest Rates and Bond Prices

Bond prices are influenced by the relationship between the stated (coupon) rate and the market (effective) rate.

Stated Interest Rate (Coupon Rate): The rate printed on the bond certificate.
Market Interest Rate (Effective Rate): The rate investors demand in the market.
Bonds are always sold at market price, which is the present value of future payments.

Exhibit 9-1: How Stated and Market Interest Rates Affect Bond Price

This table compares the stated rate to the market rate to determine if a bond is issued at par, discount, or premium.

Case	Stated Rate	Market Rate	Issue Price
A	Equals	Equals	Par (face value)
B	Less than	Greater than	Discount (below face value)
C	Greater than	Less than	Premium (above face value)

Accounting for Bonds Payable

Issuing Bonds Payable at Par

When bonds are issued at par, the cash received equals the face value. Interest payments are made periodically, and at maturity, the principal is repaid.

Example: Southwest Airlines issues $100,000 of 9% bonds at par on January 1, 2024.
Interest payments: Occur semiannually (e.g., January 1 and July 1).
Year-end accrual: Interest expense and payable are accrued for the last six months of the year.
At maturity: The company pays off the bonds by repaying the principal.

Accounting for Bonds Payable and Interest Expense with Effective-Interest Amortization

The effective-interest method is the preferred approach for amortizing bond discounts and premiums, as it reflects the time value of money.

Interest expense varies each period.
Steps:
1. Determine the exact price at issuance (present value calculation).
2. Build an amortization table to track carrying value and interest expense.

Exhibit 9-2: Amortization of Bond Discount

This table and graph illustrate how the effective-interest method gradually increases the carrying value of a discounted bond to its face value at maturity.

Issue Date	Maturity Date	Face Value	Stated Rate	Market Rate	Issue Price
1/1/2024	1/1/2029	$100,000	9%	10%	$96,149

Interest payment: Fixed by contract.
Interest expense: Increases as the bond approaches maturity.
Discount amortization: The difference between interest expense and interest payment is added to the carrying value each period.

Exhibit 9-3 and 9-4: Interest Expense and Amortizing Discount

Graphs show that interest expense rises over time for discounted bonds, while the carrying value increases to face value.

Issuing Bonds Payable at a Discount

Journal entries: Record interest expense and payment, and amortize the discount each period.
At maturity: The discount is fully amortized, and the carrying value equals face value.

Issuing Bonds Payable at a Premium

Bonds issued above face value (premium) result in a credit balance for the premium account.

Example: Southwest issues $100,000 of 9% bonds when the market rate is 8%. Issue price is $104,100.
Balance sheet reporting: Bonds payable and premium are shown together as long-term liabilities.

Long-term liabilities	Amount
Bonds payable	$100,000
Premium on bonds payable	$4,100
Total	$104,100

Exhibit 9-5: Amortization of Bond Premium

The effective-interest method reduces the carrying value of a premium bond to its face value at maturity.

Issue Date	Maturity Date	Face Value	Stated Rate	Market Rate	Issue Price
1/1/2024	1/1/2029	$100,000	9%	8%	$104,100

Interest expense: Decreases over time for premium bonds.
Premium amortization: The difference between interest payment and interest expense is subtracted from the carrying value each period.

Exhibit 9-6 and 9-7: Interest Expense and Amortizing Premium

Graphs show that interest expense falls over time for premium bonds, while the carrying value decreases to face value.

Leverage and Financial Statement Impact

The Leverage Ratio

Leverage ratios measure the extent to which a company uses debt to finance its assets. They are important for assessing financial risk.

Debt Ratio: Proportion of total liabilities to total assets.
Equity Multiplier (Leverage Ratio): Shows total assets per dollar of stockholders’ equity.
Example: Southwest Airlines has a lower leverage ratio than United Airlines, indicating lower financial risk.

Company	Average Total Assets	Average Common Stockholders' Equity	Leverage Ratio	Total Liabilities	Debt Ratio
Southwest	$35,845	$10,551	3.40	$24,682	68.8%
United	$67,766.50	$9,452.50	7.17	$60,462	89.2%

Reporting Long-Term Liabilities

Financial Statement Presentation

Long-term liabilities are reported on the balance sheet, often with details about the types and maturities of debt.

Example: Southwest Airlines reports various notes and loans with their respective due dates and amounts.

Type of Debt	Amount (in millions)
2.65% Convertible Notes due 2025	1,012
1.25% Notes due 2025	500
Payroll Support Program Loans	Various
Finance leases	117
Less current maturities	(482)
Net of debt discount and issuance costs	6,064

Disclosing the Fair Value of Long-Term Debt

U.S. GAAP encourages companies to disclose the fair value of long-term debt, which is based on quoted market prices and may differ from carrying amounts due to market fluctuations.

Fair value: The price at which the debt could be exchanged in the market.
Carrying amount: The value reported on the balance sheet.

Exhibit 9-9: Consolidated Statement of Cash Flows (Partial)

Cash flows related to long-term liabilities are reported in the financing section of the statement of cash flows.

Cash Flow Item	Amount (in millions)
Net cash provided by operating activities	5,987
Proceeds of common stock	2,094
Payments of common stock	(2,094)
Proceeds from issuance of debt and finance lease obligations	2,000
Repayment of debt and finance lease obligations	(2,000)
Net change in cash and cash equivalents	604

Summary

Bonds are a key form of long-term liability, with various types and pricing mechanisms.
Accounting for bonds involves recognizing interest expense and amortizing discounts or premiums using the effective-interest method.
Leverage ratios help assess financial risk and the impact of debt on financial statements.
Long-term liabilities are reported in detail on the balance sheet, and fair value disclosures provide additional transparency.

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